by not paying dividends represent several reasons why the corporate form is selected by tax experts for the operation of large business irrespective of the corporate statutory tax rate.
Deception #7. The working poor don’t pay taxes because income tax rates are progressive
The tax system that applies to the wealthy and large corporations differs significantly from that which applies to workers who are paid wages and are immediately subject to taxes on that labor income. This is because nearly all earned income is currently subject to tax. Earned income is also generally not offset or reduced by deductions. Any earned income is taxed immediately on the full amount without any reduction. In contrast, the wealthy and large corporations are usually able to delay (or “defer”) tax or not pay tax on the full amount of profits. Earned income is therefore always part of the tax base and almost never reduced by deductions. The progressive rate structure of the income tax does not offset these disadvantages. Labor income may always be disadvantaged under that system of automatic deferral of taxation for capital income but not labor income irrespective of any progressivity in the tax rates if there is the possibility of deferral to capital. For example, if the statutory tax rate on capital were set at 99 percent, and the tax rate on labor at only 10 percent, if deferral was still available to capital, the tax system might still favor capital despite the significant difference in the statutory tax rates. It simply is not possible to coherently discuss tax policy solely in terms of statutory tax rates without knowledge of the availability of deferral to capital under the tax laws.
Taxes are levied on earned income relatively simply: by multiplying the tax rate times the tax base. And, the tax rate on earned income is high. In addition to that high tax rate, the Social Security taxes levied in the United States are not progressively indexed.21 For labor income, a worker may often pay federal income taxes of up to 38 percent, plus state and local income taxes, often 6 percent, plus Social Security and Medicare taxes. That’s roughly 60 percent. And then, once the worker pays the 60 percent in taxes on earned income, lots of other taxes are also required to be paid, like sales taxes (often 6 percent on purchases), property taxes, (typically 3–5 percent of average earnings), gasoline tax (typically 2 percent or more of average earnings), a host of government fees (ranging from 2 percent to 5 percent of average earnings), and on and on. If all these taxes are added up, then nearly everything the worker earns is transferred back to the government in one form or another. If a worker has something left over after paying all these taxes, it should really be considered something of a miracle. One of the most significant deceptions in tax policy is encouraging workers to think that the wealthy and large corporations also pay confiscatory rates of tax similar to how workers pay taxes on their earned income. A second deception is to encourage workers to think that some progressivity in the income tax rates means that they are not paying a rate equal to that of a higher-income person; that is simply false. Wealthy people are wealthy in part because they tend to hold assets that have seen great increases in value, but they are not taxed on those increases as if they were income earned by and through work.
Deception #8. There are no social costs to high taxes on workers
The economic theory of taxation might sound complicated, but it’s simple, really. Economic theory posits that only high-income workers and firms will choose to produce less economic output if they are taxed. This posited reduction in economic output is referred to as the deadweight loss of income taxation.22 The deadweight loss from taxation is a subtraction to economic activity and to tax collections from the taxation of the wealthy only—there is no corresponding deadweight loss from the taxation of working people posited in economic theory. Thus, although evidence for the deadweight loss is lacking, it is posited to accrue only for the wealthy, not for lower-income workers. The assumption is that no matter how much tax workers are required to pay, there is no reduction in economic output from those taxes on workers. In other words, as far as economics is concerned there are no social costs to high taxes on workers. Workers simply don’t count in economic theory—exactly as Thomas Malthus said long ago.
Economics has not changed much since Malthus’s time. We have today really a formal way of applying Malthusian theory through the tax system. A significant problem in the present day is the lack of data to support these economic ideas. Scientists often call data evidence. To see if something is true, scientists like to look at data or evidence. For nearly all economic conclusions about tax policy, the data suggest the opposite result from the one proposed by economic theory. What does that mean? Often those economic conclusions are not supported by empirical evidence, and are sometimes just plain wrong.
It turns out that taxing workers at high rates creates a negative social cost. There should be a subtraction to economic output in economic theory representing a deadweight loss from labor taxation, but there isn’t. These social costs from worker taxation relate to various areas including
•Public health—Workers seem to get sick more often and require costly health care under high-wage tax regimes. The negative economic result occurs because costs of health care are quite high because another person or governmental entity must pay for the incremental health care costs resulting from taxing labor at high rates that might be avoided simply by reducing the tax rates on workers.
•Child outcomes—Workers often have children, and high taxes on workers means they have less to invest in their children. A system designed to tax parents is an expensive design because society must try to remediate any deficits that occur amidst the chaos and uncertainty of parenting on a shoestring budget.
•Reduced or eliminated small business activity—The high tax rates on workers apply also to small businesses, including most types of entrepreneurial activity. Since the tax rates are exceptionally high on small business activity, this is detrimental to the formation of small business and tends to favor large corporations in the marketplace where small business operates in competition with large corporations.
It is very important to note that the point of this book is not that high tax rates on workers are unfair. Rather, the key observation of this book is that high rates of wage taxes are expensive (or inefficient) because taxing workers creates social costs that may even exceed the amount of tax collected.
Deception #9. Workers and poor people are cognitively inferior to the wealthy and unable to make rational economic decisions
The idea of the cognitive inferiority of the poor arose in the subfield of economics referred to as behavioral economics. Although behavioral economists don’t say explicitly that the poor are not as intelligent as the wealthy, their analysis is always premised on that assumption. Rich people are presumed to be smart and able to make rational decisions in the manner economists expect. Of course, the first decision that all presumptively rational and wealthy people make is that they should pay $0 in taxes and that workers should pay all the taxes. The further implication is that the wealthy should make all economic decisions since they are able to think rationally. Notably, this was exactly Thomas Malthus’s view, so today’s economic theory has reverted to an overtly Malthusian ideal.
I wish to challenge here the views both that workers are not rational and that the wealthy are rational or at least more often rational than the poor in decision making. To do so, I need to first disprove the claim that workers or the poor are irrational under the framework of behavioral economics. That’s easy.
To my knowledge, there is no empirical data whatsoever about consumer preferences as applied in the field of behavioral economics related to taxation or tax policy that would allow for the creation of a welfare function. The absence of data means in the context of taxing sugar-sweetened beverages, for example, that it may be true that poor people make a bad decision in drinking sugar beverages, the badness of that decision to
